a$.$ Assume that your firm based in Coventry exports medical devices to Italy and receives $1,000,000$ EUR $360$ days from now. You would like to determine whether to hedge this

position. You have developed the following scenarios for EUR:

EUR in $360$ days Probability

GBP$0\mathrm{.}825\%$

GBP$0\mathrm{.}8320\%$

GBP$0\mathrm{.}8425\%$

GBP$0\mathrm{.}8525\%$

GBP$0\mathrm{.}8620\%$

GBP$0\mathrm{.}875\%$

The $360-$day forward rate of EUR is GBP$0\mathrm{.}8421,$ while the current spot rate is GPB$0\mathrm{.}8470.$ersus noDetermine the possible differences between the costs of hedging versus no hedging. what is the probability that hedging will be more costly to the firm that not hedging? Determine the expected value of the real cost of hedging and discuss whether you would like to hedge.

b$.$ current one$-$year interest rate are $1\%$ in Italy and $0\mathrm{.}6\%$ in UK$.$ Assume the same spot and forward rate form part a$.$ If you decide to hedge using money market instruments, what actions do you need to take and what would be the guaranteed GBP proceeds from the Italian sale? Which financial hedge would you choose: forward hedge or the money market hedge?

c$.$ Give examples of operational hedge of foreign exchange exposure and discuss the potential limitations of financial hedging activity.